3 Reasons Not to Buy General Motors

While General Motors might be cheap valuation-wise, there are several daunting headwinds that make this stock unattractive.

The frenzy surrounding General Motors (NYSE:GM) hasn't let up over the past several weeks. More news -- all of it bad -- continues to pour out at a time when its new leader, CEO Mary Barra, testifies on Capitol Hill over the company's handling of its recalls.

The stock is finally starting to take a beating, falling 8% last week and down 20% on the year. Sadly, I still think there could be a bit more downside.

First-quarter profits will get squeezedFour weeks ago, General Motors released a statement notifying the public that it was recalling 1.55 million more vehicles -- which were not related to the ignition switch issue -- and expects to take a $350 million charge in the first quarter for all of the recalls to date.

The company then issued a statement on April 1, saying that the first-quarter charge would increase to $750 million, after it recalled an additional 1.3 million vehicles for a power steering issue, as well as 900,000 more vehicles due to the ignition switch.

In total, 6.3 million vehicles have been recalled by General Motors since mid-February, 2.6 million of which are related to the fatal ignition switch. On April 11, the company announced that the cost of the recall would jump to $1.3 billion.

Recall costs are just part of the company's massive first-quarter costs. Below is a chart highlighting the total charges:

Fine or Cost

First-Quarter Estimated Charges

Total recalls

$1.3 billion

Venezuelan currency swings

$400 million

Restructuring costs

$300 million

Total first-quarter charges

$2 billion

Don't forget about the Justice DepartmentAlso in mid-March, the Justice Department announced that Toyota Motors (NYSE:TM) would pay a whopping $1.2 billion to settle the government's criminal investigation into the handling of the automaker's unintended acceleration issue -- a case that is similar to General Motors', and could offer a look at how the Justice Department handles General Motors as well.

It's understandable right now, based on this information, why investors would want to avoid the stock.

The automaker faces several billion dollars in losses when first-quarter charges are combined with the potential settlement with the Justice Department. For all we know, more charges could be on the way, since General Motors has increased the estimated recall cost to $1.3 billion, from an original $350 million.

Two-month hangoverThere's one more shoe -- a very expensive shoe at that -- that's waiting to drop; it concerns victim compensation.

In a previous article, I discussed the $6 billion-$10 billion lawsuit filed by a group of lawyers in Corpus Christi, Texas.

It would be highly unlikely for General Motors to fork over anywhere near the kind of money sought in the lawsuit. Perhaps several billion, but not between $6 billion and $10 billion.

But this is where things get a little hairy.

Technically, as I have interpreted, the "old GM" -- that being the company that filed for bankruptcy protection five years ago -- is the legally responsible party for compensating customers for their vehicle defects and deaths. However, since "old GM" doesn't exist anymore, no company is left bearing responsibility for compensating victims.

In other words, "new GM" -- the company that we know and invest in today -- isn't legally bound to provide compensation for victims, although Sen. Richard Blumenthal is urging the Justice Department to force GM to pay up.

With all that being said, don't expect General Motors not to pay anything. Again, as it stands, the automaker is not obligated to pay anyone. But that doesn't mean it won't.

The company recently hired Kenneth Feinberg, an attorney who made a name for himself by constructing compensation funds. Most notably, he put together victim compensation funds for the Sept. 11 attack, the Boston Marathon bombing, and the BP oil spill.

Now, just because Feinberg has been brought on board, doesn't mean that General Motors has decided to compensate victims. Barra has indicated that a decision will be made in this regard within 30-60 days.

Possible brand damageAside from a lower valuation, it may be time for investors to start considering the effects this could have on General Motors' brand. Following the government bailout -- which branded the company as "Government Motors" -- the public already had a skewed view of the automaker.

Since then, the company has done a nice job repairing its reputation by producing quality vehicles and having the government exit its position in the company. This latest development is putting a black-eye back on the brand.

March auto sales results for General Motors didn't reflect any negative buying habits from consumers. It has yet to be seen whether it will ultimately hurt the automaker's sales, but it's something investors should watch for in the monthly auto sales figures and the company's quarterly reports.

The bottom lineMaybe I'm completely wrong about GM, but the stock has declined precipitously since I began noticing the bearish headwinds. I'm not a seller by any means, but I'm still not a buyer today.

My position runs contrary to the general consensus about this stock. Shares of General Motors are very cheap on an price-to-earnings basis, sales haven't been hurt (yet), and the company pays a handsome dividend.

The company risks losing an entire year's worth of profit. Remember, a stock that's considered cheap, can always get cheaper.

Author

At The Motley Fool I cover consumer goods and industrial companies, and mainly the automakers. I am a long-term investor looking for companies with sustainable and above average growth. I also like to uncover value, dividend-paying companies. Follow me on Twitter @BretKenwell